Company History:

Krause's Furniture, Inc. is a vertically integrated manufacturer and retailer of custom-crafted upholstered furniture, including sofas, sofa beds, chairs, sectionals, incliners, and recliners, and accessories purchased from other suppliers, including occasional tables and chairs, area rugs, lamps, and fashion accessories. In January 1998 it was operating 83 showrooms in 12 states under the names Krause's and Castro Convertibles. It was the nation's largest manufacturer/retailer of made-to-order furniture.

Custom Sofas: 1973--90

Krause's Sofa Factory (originally incorporated as The Sofa Factory) was founded in San Diego or La Mesa, California, a suburb, in 1973 by Kalman and Bernelle Krause. At first they built, sold, and delivered each of their sofas themselves. As the business grew they established a factory in Brea, California. The Krauses believed that prospective customers should be able to walk into a company showroom and pick out a sofa style and fabric tailor-made for them. By 1986, when they sold the company (renamed Krause's Sofa Factory in 1984) for $30 million, there were 56 Krause's showrooms. The buyers were Ayse Kenmore and her husband, Robert, who took a 54 percent stake, and Michael Gibbons.

Krause's Sofa Factory had sales of $103 million in 1989, making it the largest factory-direct sofa manufacturer in the United States and the 17th largest furniture maker in the nation. It also believed itself to be the largest combined retailer and manufacturer of custom upholstered furniture in the United States. Its retail showrooms in 1990 averaged between 17,000 and 20,000 square feet in size to accommodate a representative sampling of 100 different sofa styles, each of which was available in 50 sizes and 1,000 fabrics or leathers. In all, the company was offering eight million combinations of custom-made sofas, love seats, and chairs.

These were not the same offerings as in the past, for Ayse Kenmore, a former Vogue and Mademoiselle staffer, had eliminated the industrial woven fabrics and box-sofa styles of Krause's early years in favor of broad stripes, delicate floral patterns, and even goose down and leather pillows for sofas ranging in price from $500 to more than $1,000. "She has a very clear idea of where she wants to take Krause's, which is toward upscale affordability," said a supervisor at Basso & Associates, which handled Krause's advertising, in a 1990 article in the Orange County Business Journal.

Krause's Sofa Factory expanded out of California for the first time in 1990, when it opened two showrooms and a distribution center in Houston. By May 1991 there were 67 showrooms, of which 46 were in California and 21 in six other western states. About 75 percent of its products were being manufactured at its leased 250,000-square-foot plant in Brea. The company, however, was not doing well, incurring a net loss of $2.6 million in fiscal 1990 (the year ended September 30, 1990), on sales volume that had slipped to about $86.6 million.

Mired in Red Ink: 1991--96

In April 1991 a subsidiary of Worth Corp., Keegan Management Co. (a subsidiary of KMC Enterprises, Inc.), purchased 62 percent of the outstanding common stock of Krause's Sofa Factory for $6.14 million. (Worth was one-third owned by Worms & Co., the U.S. unit of a French investment firm.) Other investors also purchased common stock that resulted in total net new equity of about $5 million for Krause's. Gibbons, now the largest individual shareholder, remained president and chief executive officer of the firm.

With this cash in hand, Krause's Sofa Factory began picking up other furniture stores struggling to survive in recession-struck California. By the end of 1991 the company had taken over two former RB Furniture stores, in Seattle and near Mesa, Arizona. Earlier, it had occupied three former Furnishings 2000 locations in southern California. Krause's also expanded its product line, adding more leather at the high end of the market ($1,400 to $1,999) while also introducing $399 promotional made-to-order sofas for the first time since the 1970s. The company lost money again in fiscal 1991, but Gibbons said the figure was only about $1 million, less than the deficit in the previous fiscal year. Later, however, the 1991 loss was put at $6.7 million on revenues of $89 million. Still heavily exposed to the struggling California economy, Krause's lost $3.4 million in calendar 1992 on revenues of $87 million.

Krause's Sofa Factory had long been planning an entry into the Midwest, and in December 1992 Gibbons said the company would enter the Chicago metropolitan area during the following year. After that, he vowed, it would fix its sights on the East Coast. The company's five-year goal, Gibbons added, was 250 units nationwide. Krause's California factory/warehouse complex had been expanded in 1990 to support up to 115 showrooms. After the Chicago stores were in place, Gibbons said, the company would assess its production needs and likely would expand or add facilities to support growth.

Krause's Sofa Factory's move to the East Coast came sooner than expected. In May 1993 the company acquired Castro Convertible Corp., a privately held firm with 18 showrooms in the tristate metropolitan New York City area and Florida and annual sales of about $20 million. The business was founded by Bernard Castro, a Sicilian immigrant who began reupholstering sofas in New York City in 1931. He was an early pioneer in developing the trifold mechanism for sliding a bed frame and mattress out of a sofa that found a ready market among apartment dwellers with limited space.

Like Krause's, Castro Convertibles offered a variety of frames and covers that customers could mix and match. At one point the company had two factories producing 100 designs and selling sofas out of 48 showrooms in 12 states, but business shifted to lower-priced makers. Although Castro's showrooms and retail employees were retained, the remaining factory, at New Hyde Park, Long Island, was closed, with production assumed at Krause's Brea plant. The acquisition raised the number of company showrooms to 87.

Worth Corp., later in 1993, purchased the remaining stock of Krause's Sofa Factory, exchanging it for its own stock in a transaction valued at $7 million to $7.5 million. Stephen Anderson then replaced Gibbons as president of the firm. At the end of the year Worth announced it had raised $12.2 million from the sale of shares of convertible preferred stock and would use the money to finance Krause's growth and prepay some high-cost debt. When Worth sold its 18 percent share in Mr. Coffee, Inc. in 1994 for $23.2 million, more capital became available for Krause's, which was now Worth's only business. Worth renamed itself Krause's Furniture Inc. in December 1994.

Anderson concentrated his efforts on improving factory production. Like many companies, Krause's Furniture was registering a high proportion of its sales from a relatively small percentage of product. Yet production was based alphabetically by style, without considering that 20 to 30 percent of the styles were responsible for 70 percent of the volume. Anderson changed this so that high-volume items would move through the plant first. This enabled the company to trim delivery time from five weeks to four. He was also planning, in mid-1995, to cut the number of frames, or chassis, used in production from the current eight to ten to only three or four, without reducing the number of styles or fabrics used.

After incurring a record loss of $10 million on revenues of $97 million in 1993, Krause's emerged in the black the following year, earning net income of $5.8 million on record revenue of $116.5 million. This, however, was only due to $12.1 million from the Mr. Coffee sale, which was applied toward virtually eliminating the company's long-term debt of $17.7 million at the end of 1993.

Anderson's attention turned in 1996 from improving production to upgrading Krause's Furniture's stores, which in April of that year consisted of 83 company-owned showrooms and four franchised outlets. These currently averaged about 13,500 square feet, with some in the 15,000- to 20,000-square-foot range, but Anderson said the optimum size would be 7,000 to 8,000 square feet, claiming that the existing stores were displaying too wide a variety of upholstery. "We really need to show 30 or 50 [of the 100 or more] styles at the most," he said. The number of fabric offerings had been halved to about 500 by this time. Accordingly, the company had begun subleasing space in some of its large stores to complementary home furnishings retailers.

Krause's also was paying more attention to selling occasional tables, lamps, rugs, and other merchandise needed to create appealing living room vignettes. "We used to just line up sofas and accent them with some tables," Herb Friedman, senior vice-president of marketing and strategic planning, told a Furniture Today reporter. "What we're really trying to do now is create room environments that best show our mass customization capabilities." These accessories, obtained from outside sources, were accounting for about 10 percent of Krause's sales, but the company wanted to double the ratio to 20 percent.

Under Hawley's Management: 1996--98

Although Krause's Furniture's revenues rose to $122.3 million in fiscal 1995 (the year ended January 29, 1996), the company lost $8.7 million, and its stock sold for as little as 50 cents a share. In August 1996 Philip M. Hawley was appointed the company's new chief executive officer. He had formerly run Carter Hawley Hale Stores, a retailing giant that--renamed Broadway Stores--was purchased by Federated Department Stores in 1995 after emerging from bankruptcy. Hawley hoped to turn the company around with a $10 million investment from GE Capital Services--half in stock and half in debt--and $4 million raised by selling new stock at $1 a share to other private investors, including Hawley himself. Another $3 million of existing debt was converted to common stock at $1 a share. GE Capital Services was a unit of GE Capital Corp., which was in turn part of General Electric Co.

One of Hawley's first moves was to replace the Krause's Furniture executives who he claimed "never walked away from the factory-outlet business." He continued the previous policy of upgrading the company's stores, announcing in August 1997 that Krause's would remodel 50 of its 80 showrooms over the next 30 months and also would open 36 new outlets. "We have always had an excellent product," Hawley declared, "but in recent years, sales have unquestionably been hurt by the dated and austere look of our stores--many of which have changed little since our company was founded." The new showrooms, based on three already completed, were to feature brighter colors and better lighting as well as displaying the sofas in living room groupings instead of arranged in rows as in a warehouse. The company was also quietly changing the name of its main retail chain from Krause's Sofa Factory to merely "Krause's," with the subtitle, "Custom Crafted Furniture."

Paying for this program presented a problem, since Krause's Furniture in early 1997 ended another fiscal year in the red--a record $13.4 million on falling revenues of $112.7 million. However, the company had lined up $7.5 million in new financing, underwritten by GE Capital Services and the Permal Group--two of the largest stockholders&mdash&plus;us Congress Financial Corp. This came in the form of a $3.5 million standby credit facility, a $1 million addition to an existing revolving credit line, and $3 million in long-term debt, which would be used to pay down existing revolving loans.

During fiscal 1997 (the year ended February 1, 1998), Krause's Furniture endured its seventh consecutive year of operating deficits, recording a net loss of $7.5 million on net sales of $115.2 million. Hawley pressed on, however, with the plan to remodel the stores--even accelerating it with the vow to remodel 65 by the year 2000, with the remaining 15 to close their doors and reopen in better locations. Twenty-two existing showrooms had been remodeled by the end of January 1998. In addition, Krause's intended to open 20 new stores in both 1998 and 1999 and 25 stores a year thereafter. A Castro Convertibles gallery was to be placed in all Krause's remodeled and new showrooms.

The new outlets, Hawley said, although costing about $285,000 each to open, would pay for themselves in 9 to 12 months and then contribute to positive cash flow. Many were to be in underrepresented markets such as New Mexico and Florida. By clustering stores in a few markets the company could save on advertising expenses. Hawley intended to try to put new and relocated stores right next to Krause's competitors. He explained, "We like to think if people have a choice, we'll win." The company was also trying to improve its bottom line by raising prices, cutting promotional discounts, changing the sales commission structure, and refocusing advertising efforts. In addition, it introduced 12 new sofa styles in fiscal 1997.

Some 4.4 million shares of Krause's Furniture stock (2.3 million new shares plus 2.1 million offered by Worms et Cie, the French investment firm) were sold to the public in March 1998 at $3 per share. GE Capital continued to be the main stockholder, with 30 percent of the shares at the end of April 1998. Worms still held 14 percent.

At the end of fiscal 1997 Krause's Furniture was operating 83 furniture showrooms in 12 states, 69 under the Krause's name and 14 under the Castro Convertibles name. Forty-one were in California and 13 in the New York City metropolitan area, including New York, New Jersey, and Connecticut. The other states with company showrooms were Arizona, Colorado, Florida, Illinois, Nevada, New Mexico, Texas, and Washington. Selling space in retail showrooms varied in size from 1,400 to 23,400 square feet, with an average size of 12,100 square feet.

Customers were able to choose from more than 60 styles and 40 sizes of sofas, incliners, recliners, sectionals, sofa beds, and chairs, which they could customize with 800 fabrics and 50 leathers. During the fiscal year accessories, custom-made chairs, and recliners accounted for five, eight, and seven percent, respectively, of company sales. Except for a few styles of occasional and reclining chairs that Krause's purchased from outside vendors, the company was manufacturing all of the upholstered furniture offered in its showrooms in its Brea facility. An assortment of tables, area rugs, lamps and wall decor, and nonupholstered custom-made chairs and recliners were being supplied by outside vendors. Merchandise purchased from other suppliers was accounting for about nine percent of net sales.